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How ECB failed to reassure investors

Italy has to borrow more than 500 billion euros to repay existing debt

In spite of a series of emergency statements from the European Central Bank, finance ministers of the G7 developed nations, and the IMF, the value of shares in Asia continued their slide of last week and the dollar weakened - and those trends look set to continue when European and US markets open.

On the face of it, the main source of stress in markets may not be the downgrade of US government debt by the ratings agency Standard & Poors, because the price of 10 year government bonds actually rose a bit overnight - which is the reverse of what should happen if investors agreed with S&P that the prospects for the US repaying all its debts have worsened.

That said, there is a peculiar internal contradiction in markets that has been created by S&P's downgrade: on the one hand it should make US government bonds less attractive to own; on the other, for those who still engage in the knee-jerk policy of buying US government bonds and shunning shares when the world seems a riskier place, the downgrade's heightening of perceived risk in the financial world makes US government debt seem more attractive.

Welcome to the surrealism of global market behaviour.

'Mortal wound'

But as I said over the weekend, it is the perceived inadequate response of eurozone governments to the rising borrowing costs of Italy and Spain that is investors' and creditors' more pressing worry.

Andrew Wood reports on reaction from Asian markets as "America is still the place they are most worried about".

But the ECB made it clear it would be doing so with extreme reluctance. Also the ECB implied that it would buy Spanish and Italian bonds only until eurozone governments have ratified a rescue package for their currency union that was agreed on 21 July, which would allow their bailout fund - the European Financial Stability Facility - to buy the debt of eurozone members facing funding difficulties.

Although France and Germany insisted in a joint statement that their parliaments would ratify the rescue package by the end of September, ratification by all sovereign members can't be taken for granted (the perils of living in a democracy).

And there's another thing which spooks investors: eurozone governments have not done the one thing investors most want, which is to agree to massively increase the size of the EFSF.

Here is the relevant statistic. Over the next five years, Italy has to borrow more than 500 billion euros, simply to repay existing debt that is set to mature. On top of that, Italy will have to borrow more to finance its deficit, the gap between tax revenues and spending.

To put it another way, Italy's potential financing requirements on its own would exhaust the resource of the EFSF, based on its current size, if investors were to shun Italy altogether.

That is why investors see any purchases by the European Central Bank of Spanish and Italian debt as - at best - a sticking plaster. ECB purchases would not provide long-term sustainable demand for Spanish and Italian bonds.

The sticking plaster is only useful if it gives Italy and Spain sufficient time to persuade the markets that they have their deficits on a sustainable downward trend and their public finances are being properly fixed.

But if in the coming weeks Italy and Spain fail to do that, declining confidence in their ability to repay their debts will look even more like a potentially mortal wound for the eurozone.

Labour would reduce tax relief for those earning £150,000 or more a year, shrink maximum pension pots to £1m and cut maximum annual pension contributions to £30,000 to pay for a cut to £6,000 in student fees.

Comment number 127.

Another 10% fall over the week should also hopefully be a knockout punch to those greedy guzzlers who were gambling on commoditys etc & forcing foods etc up.I think we will soon see MASSIVE quantative easing by both USA & EUR, devaluation + INFLATION.

Comment number 126.

CryFreedomMachine8th August 2011 - 15:21

Theresa May returns after London violence

LOL, the world economy, including UK is being smashed beyond recognition by markets, yet clown Cameron is more interested in tipping a waitress with change from 10 Euros, who didnt provide him with waitress service.

Basically, Euro policy/strategy is also to tip the financial markets for services they are NOT providing.

Comment number 125.

CryFreedomMachine8th August 2011 - 15:17

Best thing is to just let the markets bottom out instead of throwing money at those financial gamblers who seek to gain from it.

If the market bottoms out then we have a stronger foundation to build on, instead of this pretentious confidence boosting pathetic strategy which just further indebts nations taxpayers & future generations.

Comment number 124.

stevenhawkingsfootballboots8th August 2011 - 14:47

What business are you referring too?, selling fruit at the market stall???....You can make money our of these markets if you have about 100 million behind you which is a rarity....I think you'll find alot of traders who trade size and trade outright have done their beans over the last few days.

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